Online trading of currencies (Forex), cryptocurrencies, and CFD deals with other financial assets (stocks, gold, oil, etc.) offer unique opportunities for investors and traders. However, to achieve long-term profitability and minimize risks, proper capital management is essential. This is where the concept of handling capitals, or 'money management' becomes significant.
Capital controlling, also known as money management, is a strategy that determines how an investor or trader distributes their capital among various financial assets and transactions, as well as how they control risks and manage position sizes. Financial markets can be volatile and unpredictable. The primary goal of money management is to preserve as much of the trader's or investor's funds as possible during periods of loss, while also effectively capitalizing on profitable trading opportunities. The main components of money management include:
– Position Size: Money management determines what percentage of your capital you are willing to risk on a single transaction. Many well-known professionals advise limiting risk to no more than 1-2% of total capital for a single position. For example, if your initial capital is $10,000, the maximum risk for one transaction should not exceed $100-200.
– Asset Diversification: Money management also involves distributing capital among various financial assets. The diversity of assets offered by the broker NordFX allows for risk reduction and a more resilient portfolio. For instance, instead of investing all your capital into one currency pair on the Forex market, you can distribute it among multiple currency pairs, stocks from different companies, or other financial instruments. This way, even if one position incurs a loss, others may generate profit, helping to offset losses and preserve capital.
– Determining Stop-Loss Levels: Money management includes determining stop-loss levels for each transaction. A stop-loss is a preset level at which the position will be closed to prevent further losses. Setting stop-loss levels is based on market analysis and the size of losses you are prepared to bear. This helps protect your capital and prevent more severe losses in case of unfavourable market movement.
Example 1. Position Size: Let's say you have a capital of $10,000, and you apply a management strategy of risking no more than 2% on a single transaction. This means you would open a position worth $200. In a more complex scenario, you could break down the transaction into several stages, i.e., gradually increasing the volume of the position (for example, first opening a position worth $100, then increasing it by $50, and then by another $50, bringing the total volume to $200). In case of a loss-making transaction, you would close the position (manually or via a stop-loss order) when the losses reach $200.
Example 2. Asset Diversification: Suppose you distribute your capital among several financial assets. For instance, you might invest 30% in currency pairs on the Forex market, 30% in company stocks, 25% in gold and silver, and 15% in cryptocurrencies. This asset diversification can protect you from potential losses in one area and create profit opportunities in another. However, to effectively hedge risks, consider how these financial instruments correlate with each other (direct or inverse correlation).
Example 3. Defining Loss Levels: Suppose you have a position in the CFD market for XYZ company shares. You place a stop-loss order at a level 5% from its purchase price. For example, if you bought the share for $100, your stop-loss order would be set at $95. If the cost of this security falls to this level, the position will be closed to prevent further losses.
It's important to note that Forex and CFD markets are subject to risk, and no strategy can provide full protection against unfavourable situations. Therefore, if you frequently see your stop-loss orders being triggered, you might be better off stopping your trading, taking a break, and carefully analysing the reasons for the losses. It's crucial to note that gambling can be very harmful, and a trader must learn to manage their emotions to correctly assess the situation. It's possible that your trading style and strategy do not suit the current market volatility, and you need to wait until the situation becomes calmer. Perhaps, you should apply your strategy to transactions with other financial instruments, or even change it to another one.
Here are some pieces of advice from renowned investors and traders regarding capital handling (money management):
● Warren Buffett:
– "Don't risk what you have for what you don't need."
– "Preserve your capital. Once lost, it takes significantly more money to get back in the game."
– "Don't take on excessive risks. Better to earn less and preserve your capital."
● Paul Tudor Jones:
– "The most important thing in investing is preserving your capital. Profits will take care of themselves."
–"Always manage your risk. If you can't manage risk, you'll never achieve success."
● George Soros:
– "Once you set a stop-loss level, never change it. It helps you keep your emotions in check and avoid substantial losses."
– "Don't risk more than 2% of your capital on a single trade. It helps you preserve enough capital for subsequent opportunities."
● Ray Dalio:
– "Distribute your capital among various assets and strategies. Don't put all your eggs in one basket."
– "Profits and losses are an inevitable part of trading. It's crucial to learn how to manage risks and control your emotions."
● Linda Raschke:
– "Don't add capital to a losing position. Better limit your losses and reallocate your capital to more promising opportunities."
– "Stick to your strategy and plan. Don't let emotions influence your trading decisions."
These pieces of advice from renowned investors and traders underline the importance of capital management, its preservation (even at the expense of profit), and risk control. Don't forget that capital management is a process that requires constant monitoring, analysis, and adaptation. For this, each trader and investor should develop their own strategy, considering their financial capabilities and goals. It is also necessary to remember the importance of learning, developing financial skills, and constant improvement in the field of trading. Only a combination of all these factors will pave the way for you from random successes and failures to professionalism and stable profit.